On May 6, 2010, the stock market experienced a “flash crash”; the Dow plunged 998 points (most of which was in just a few minutes) before (mostly) recovering. Nobody was quite sure what caused it. An interesting theory from Nanex.com, based on extensive analysis of the actual electronic stock-quote traffic in the markets that day and other days, is that the flash crash was caused (perhaps inadvertently) by a kind of denial-of-service attack by a market participant. They write,
While analyzing HFT (High Frequency Trading) quote counts, we were shocked to find cases where one exchange was sending an extremely high number of quotes for one stock in a single second: as high as 5,000 quotes in 1 second! During May 6, there were hundreds of times that a single stock had over 1,000 quotes from one exchange in a single second. Even more disturbing, there doesn’t seem to be any economic justification for this.
They call this practice “quote stuffing”, and they present detailed graphs and statistics to back up their claim.
The consequence of “quote stuffing” is that prices on the New York Stock Exchange (NYSE), which bore the brunt of this bogus quote traffic, lagged behind prices on other exchanges. Thus, when the market started dropping, quotes on the NYSE were higher than on other exchanges, which caused a huge amount of inter-exchange arbitrage, perhaps exacerbating the crash.
Why would someone want to do quote stuffing? The authors write,
After thoughtful analysis, we can only think of one [reason]. Competition between HFT systems today has reached the point where microseconds matter. Any edge one has to process information faster than a competitor makes all the difference in this game. If you could generate a large number of quotes that your competitors have to process, but you can ignore since you generated them, you gain valuable processing time. This is an extremely disturbing development, because as more HFT systems start doing this, it is only a matter of time before quote-stuffing shuts down the entire market from congestion.
The authors propose a “50ms quote expiration rule” that they claim would eliminate quote-stuffing.
I am not an expert on finance, so I cannot completely evaluate whether this article makes sense. Perhaps it is in the category of “interesting if true, and interesting anyway”.
